Capital Formation in Telecommunications
U. S. House of Representatives Committee on Financial Services Subcommittee on Domestic Monetary Policy, Technology and Economic Growth Bryan J. Mitchell Chairman and CEO MCG Capital Corporation April 18, 2001
MCG Background
• Solutions - Focused
– Working with high growth, smaller private businesses – Assist in prioritizing opportunities and managing risks of growth
• Expert – Activist
– Focus on specific sectors of the economy – Develop financial, operational and regulatory expertise – Actively apply to portfolio companies
• Fundamental Investment Thesis
– Trade upside for less speculative, more stable path to value creation
MCG Background
• Current investment portfolio of $675 mm
– 25% in telecommunications – Remainder in Media, Information Services and Technology
• Recently completed IPO and Bond Offering
– Capital Markets validation of investment thesis
• Active investor for over 10 years
– Deployed over $2B in capital in over 200 transactions since 1990
MCG’s Investment Activities
• • • •
Fundamentals Growth Cash Flow Collateral Value
MCG’s Telecommunications Investment Activity
• Long Distance • Niche Markets
– Prepaid; conference calling; hospitality
• Integrated Services
– Local-long distance-data bundling; messaging
• Support Infrastructure • UNE-P CLEC
MCG Investment Thesis
• High Net Present Value Customer Acquisition • Predictable Revenues • GPM that supports S, G & A and a return on capital within an appropriate time value of money framework • Discernable ROI on facilities
Attraction of the Market
• Favorable Regulatory Environment
– Telecom Act of 1996
• Significant Price/Value Proposition
– Greatest value proposition to small business and residential customers; many customers
• Smaller competitors can outperform
– Better at basics- customer service; billing clarity; provisioning – Innovation encouraged by competition
Telecom Act of 1996
Created Attractive Framework for Multiple Entry Strategies • Total Service Resale – retail minus
– new entrant as marketing and billing agent
• Facilities – significant PP&E investment
– use components of public switched network
• UNE-P – network elements recombined
– Cost plus that facilitates innovation
Total Service Resale
• Seemingly low cost entry strategy • Investment capital to acquire customers • Customer acquisition model is critical • Low gross profit margin • Long time frame to ROI
Facilities
• • • •
Significant entry costs Reliant on favorable access terms Long scaling time frame High gross margin upon reaching scale • Target high margin; larger users
UNE-P
• Low cost market entry • Shorter payback on customer acquisition • Viable gross margins with moderate scaling • Capital expenditures focus on customer • Creates framework for product/service innovation • Stepping stone to the high margin facilities
Brilliance of the Act
Have to support all three entry models: • Ubiquity of resale • Opportunity for innovation, effective service for average customer and more stable and visible path to profitability of UNE-P • Facilities strategies to serve the most complex customers and generate highest margins The three together will facilitate capital formation
What Happened?
• Capital markets went for the brass ring
– Total market size and valuation creation opportunity created speculative bubble – Ignored rational stepped framework that was established in the Act – Don’t throw the baby out with the bath water
What’s Next?
Is there still a reason to force the incumbents to keep open all three entry strategies? FCC’s Triennial Review Proceeding will determine outcomes
Public Interest
• Nobody is going to build de novo networks to serve the small guy – competitive telephony as configured allows all to benefit as each strategy flourishes over time
Buy Rate
• The incumbents need to be held to cost studies so the buy rates on the public switched network elements can support a margin that perpetuates capital in-flows
Enforcement
• Old monopolies die hard and as such enforcement mechanics should not be undermined • Tauzin-Dingell appears to created a protected safe harbor for the Bells to invest in next generation networks that won’t be subject to open access as provided for by the Act
MCG Contacts
Bryan J. Mitchell Chairman and CEO 1100 Wilson Boulevard Suite 800 Arlington, VA 22209 (703) 247-7510 (703) 247-7505 (Fax) BMitchell@MCGCapital
John S. Patton, Jr. Managing Director 1100 Wilson Boulevard Suite 800 Arlington, VA 22209 (703) 247-7515 (703) 247-7505 (Fax) JPatton@MCGCapital
Press Inquiries: Sherry L. Edwards, 703 247-7502